8 APPENDICES
8.1 APPENDIX A – COST BENEFIT ANALYSIS
It is not ideal to use this method to decide on one system compared to another, as the overall costs and benefits should be compared for the planned lifetime of the system.
Return on investment analysis (ROI)
The ROI% can be used to measure profitability by comparing the return (total net benefits) from the system against the investment (the total costs) as follows:-
ROI = ((total benefits – total costs) / total costs) × 100 Using the data from Fig 7.1 above gives: –
((158500 – 135800) / 135800) × 100 = 16.7% ROI
Download free eBooks at bookboon.com Click on the ad to read moreClick on the ad to read moreClick on the ad to read moreClick on the ad to read moreClick on the ad to read moreClick on the ad to read moreClick on the ad to read moreClick on the ad to read moreClick on the ad to read moreClick on the ad to read moreClick on the ad to read moreClick on the ad to read moreClick on the ad to read moreClick on the ad to read moreClick on the ad to read moreClick on the ad to read moreClick on the ad to read moreClick on the ad to read moreClick on the ad to read moreClick on the ad to read moreClick on the ad to read moreClick on the ad to read moreClick on the ad to read moreClick on the ad to read moreClick on the ad to read moreClick on the ad to read moreClick on the ad to read moreClick on the ad to read moreClick on the ad to read moreClick on the ad to read moreClick on the ad to read moreClick on the ad to read moreClick on the ad to read moreClick on the ad to read moreClick on the ad to read moreClick on the ad to read moreClick on the ad to read moreClick on the ad to read moreClick on the ad to read moreClick on the ad to read moreClick on the ad to read moreClick on the ad to read moreClick on the ad to read moreClick on the ad to read moreClick on the ad to read more
EXPERIENCE THE POWER OF FULL ENGAGEMENT…
RUN FASTER.
RUN LONGER..
RUN EASIER…
READ MORE & PRE-ORDER TODAY WWW.GAITEYE.COM Challenge the way we run1349906_A6_4+0.indd 1 22-08-2014 12:56:57
Organisations often set a minimum ROI which may be based on the rate they could obtain by investing the money in other ways, such as an investment bank account. Note.
This approach considers the overall rate of return over the lifetime of the system and does not consider annual rates of return, which could vary significantly. ROI can be used to compare different systems proposals. It is, however, worth noting that the timing of the costs and benefits is not considered. These shortcomings are addressed when carrying out a net present value analysis.
Net present value (NPV)
The NPV can be used to consider the profitability of a system and is the difference between the present value of cash income (benefits) and the present value of cash outgoings (costs, including initial development costs). The time value of money works on the basis that a unit of currency held now is worth more than the same unit of amount which would be received in a year’s time, as money currently held can be invested and could be worth more in the future.
The present value of a future unit amount e.g. $ or £, is the amount of money invested at a specific interest rate today which grows to become the future unit value at a specified future point in time. This specified interest rate is referred to as the discount rate. An organisation will choose a discount rate that represents the expected rate of return from investing in a safe form of investment such as a savings account, rather than invested in a new system. Organisations normally expect to see a rate of return that is higher than the discount rate in order to take account of the increased risk of developing a new system rather than just investing the money. The NPV formula involves multiplying each of the incomes and outgoings by the relevant present value factor which is based on the year the incomes/outgoings will happen. Then all the time-adjusted incomes and outgoings are totalled. Finally, the NPV can be calculated by subtracting the total present value of the costs from the total present value of the benefits
NPV = ∑ {Net Period Cash Flow/(1+R)^T} – Initial Investment where R is the rate of return and T is the number of time periods.
For example, take a project with an initial cost of £20,000 over 3 years with a discount rate of 3.5%.
NPV = {£2,000/(1+.035)^1} + {£10,000/(1+.035)^2} + {£12,000/(1+.035)^3} – £20,000
= £1932.37 + £9335.11 + £10823.31 – £20,000
= £2090.79
Download free eBooks at bookboon.com
To assist with the present value analysis, present value tables are available which show values at various rates over a number of years. There are also Internet calculators available (Net Present Value, n.d.)and spreadsheet software such as Microsoft® Excel can be used for the calculations.
If the NPV value is positive, the system would be feasible as it would return more money than the amount invested, however all development projects have risks and so organisations will still need to consider the return carefully. NPV analysis can be used to compare different system proposals.